Social Security and Education

Studies | Education | Social Security

No. 240
Wednesday, January 31, 2001
by Dr. Liqun Liu and Dr. Andrew J. Rettenmaier


Social Security's Costs and Benefits

Figure I - Social Security Monthly Benefit Formula

Typically the costs of an "investment" in Social Security are some 40 years of tax payments. The benefits are 15 to 20 years of retirement pension benefits.

We limit our analysis in this paper to the 10.6 percent of payroll tax that goes to Old Age and Survivors Insurance (OASI) because it is possible to isolate its costs and its retirement, survivors and spousal retirement benefits.

"Typically, the costs of an 'investment' in Social Security are some 40 years of tax payments, and the benefits are 15 to 20 years of retirement pension benifits."

Eligibility Requirements for OASI Benefits. The primary old age benefits are the worker's own retirement benefits and his or her spouse's benefits. Spouses draw benefits on a worker's account if they do not qualify for their own benefits or if their own earned benefits are less than 50 percent of the worker's benefits. For example, individuals who work fewer than 10 years do not qualify for Social Security, but they are eligible for retirement benefits equal to 50 percent of their working spouse's benefits while the worker is alive. Also, individuals whose own benefits are less than 50 percent of their spouse's are entitled to the higher amount, and they draw benefits on their spouse's accounts.

The Worker's Retirement Benefits. At retirement, workers begin collecting Social Security benefits that are loosely tied to the taxes they paid into the system over their lives. The Social Security Administration (SSA) keeps track of workers' taxable earnings from the time they enter the labor force until retirement. A worker's initial benefit is calculated by converting earnings in earlier years to dollars comparable to those in the year the worker turns 62, using a national average wage index that is updated annually by the SSA. Earnings beyond the age of 62 enter the calculation without being indexed. The 35 highest indexed annual earnings are added together and divided by 420, the number of months in 35 years, to obtain the worker's average monthly earnings.

The Benefit Formula. As Figure I shows, the worker's initial Social Security pension is computed from the average monthly earnings using a formula that replaces more of the earnings of low-income than of high-income workers.

  • In 2001 retirees receive 90 cents for each of the first $561 of indexed monthly earnings.
  • They receive an additional 32 cents for every dollar of earnings over $561 and less than or equal to $3,381, and 15 cents for every dollar in average monthly earnings above $3,381.
  • Based on this formula, a worker who had average monthly earnings of $1,500 receives a pension equal to $805, replacing 54 percent of earnings.
  • If a worker had average monthly earnings of $4,000, he or she receives a pension of $1,500, or only 38 percent of preretirement earnings.

"Accounting for survivors benefits is important."

Survivors Benefits. Accounting for survivors benefits is important because they have been overlooked in some previous studies of the Social Security investment. The impact of survivors insurance, particularly benefits that arise from premature deaths, has eluded careful empirical study. Supporters of the Social Security program often argue that groups whose members die early in life disproportionately benefit from survivors insurance.2

It is useful to think of survivors benefits in two parts. First are the benefits resulting from premature deaths or deaths prior to reaching the retirement age.

  • In the case of a premature death, each surviving child under the age of 18 is entitled to 75 percent of the benefit to which the worker would have been entitled based on his or her earnings history.
  • A surviving spouse also is entitled to 75 percent of the decedent's benefit as long as a dependent child under the age of 16 is in the household.
  • The total family benefit is subject to a maximum that varies but is usually 150 to 180 percent of the decedent's benefit.

Second and more common are survivors benefits resulting from deaths after retirement.

  • A surviving spouse is entitled to 100 percent of the decedent's benefit if it is higher than the benefit to which the spouse would have been entitled based on his or her earnings history.
  • A child under 18 is entitled to 75 percent of the benefit to which the worker would have been entitled.
  • The total family benefit is subject to a maximum that varies but is usually 150 to 180 percent of the decedent's benefit.

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